Know Your Rate: How Oil Prices Affect Mortgage Rates

On the right-hand side of the Quicken Loans homepage, there’s a box that shows our mortgage rates. You might be wondering how we come up with them. As easy as it might be to believe that these numbers are made up out of thin air, there are actually several factors at play in the financial markets.

One thing you might not think affects mortgage interest rates, however, is the worldwide price of oil. Believe it or not, oil investments – and plenty of other things – have an indirect effect on mortgage rates.

To understand why, it helps to know that one of the strongest predictors of mortgage rates is the yield on a 10-year Treasury note. Basically if the yield is low, so are mortgage rates.

Bill Banfield, director of Capital Markets at Quicken Loans, discussed why the buying of bonds can represent relative safety for oil investors, and what oil prices mean for the world’s economy.

“Oil prices are falling, in large part, because there is less demand,” Banfield said. “Less demand comes via weakening economies across the globe. The lower oil prices may also disproportionately affect countries like Russia, which are already suffering from instability. All of this leads to a flight to quality, and the safe haven is almost always the U.S. Bond Market.”

Oil and many other commodities are traded in the futures market. In this market, buyers and sellers agree on the prices at which future barrels will be bought and sold. Futures are risky for both sides of the transaction because production costs can go up or down between the time the agreement is made and the time payment takes place.

With prices dropping and no one quite sure when they’ll stop, U.S. bonds give investors a certain comfort that the oil market isn’t currently providing. (Treasury bonds will always be paid off to prevent the government from losing the confidence of its investors and creditors at home and abroad.)

The problem for these investors is that everyone has the same idea. If everyone starts buying bonds, it drives down yields because the government doesn’t have to offer such a high rate of return to get people to buy. This, in turn, drives down mortgage rates.

It should be noted that the 10-year Treasury note only affects the base mortgage rate you can get. A number of factors go into the actual interest rate a client can get, including their credit score, the number of points paid on the mortgage and the down payment amount.

Hopefully you know a little bit more about the way mortgage rates are set. Come back next week to learn how a single ream of paper sold in Scranton, Pennsylvania affects the price of tea in Beijing. I’m just kidding. I have no idea whether it does or not.

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